Your pension is often your best tool for retirement saving because, not only do you build your own contributions, but you can also benefit from employer payments and tax relief from the government. As such, payments into a pension could be “worth” more than contributions to other types of savings and investments.
The savings in your pension are invested too, so you might benefit from growth over time. Further to this, you won’t pay Capital Gains Tax (CGT) or Dividend Tax on any investment returns, so pensions are a tax-efficient way to build wealth for retirement.
As such, you might want to explore ways to maximise the amount you pay in. You could do this by increasing your contributions, but you might not want to reduce your take-home pay.
Fortunately, there is a way to potentially pay more into your pension without affecting your monthly income: salary sacrifice.
Read on to learn how salary sacrifice could help you reach your retirement goals faster.
Salary sacrifice allows you to exchange part of your earnings for benefits, including pension contributions
Certain employers offer a salary sacrifice scheme, which allows you to give up a portion of your annual earnings in exchange for certain benefits. This might include a company car, private healthcare, or pension contributions.
Your employer normally deducts your Income Tax, National Insurance contributions (NICs), and pension contributions from your salary and then pays you the net amount.
However, using salary sacrifice, you could give up a portion of your earnings equal to your pension contribution, which your employer would pay directly into your pot. Your Income Tax and NICs would then be calculated based on a lower salary. Consequently, you would pay less tax and could increase your take-home pay, while maintaining the same pension contribution.
Alternatively, you might decide to increase your pension contribution, while your take-home pay remains the same. This could make a significant difference to the size of your pension pot in later life.
It’s worth noting that your employer will pay reduced NICs on your salary, so they also benefit. They might even agree to contribute this saving to your pension.
Using salary sacrifice to increase pension contributions could help you retire earlier
Using salary sacrifice to increase your pension contributions could significantly boost the size of your pension pot in later life. In some cases, you might even be able to reach your savings goals sooner, meaning you can retire earlier.
In July 2024, PensionsAge reported that if you earned the average salary of £34,963, you could increase your take-home pay by £140 a year through salary sacrifice. If you contributed these additional funds to your pension, and your employer agreed to pay their NI saving in too, you’d add an extra £463 to your retirement pot each year.
Assuming you achieved 5.4% growth annually, this could increase the size of your pension pot by £35,900 after 25 years.
If you’re a higher earner, the increase to your retirement savings could be even greater. As a result, salary sacrifice could allow you to build your pot faster and potentially retire earlier than planned. Alternatively, if you maintain the same retirement date, you may be able to afford a higher standard of living.
Lowering your salary could affect your ability to borrow or claim certain benefits
While salary sacrifice could help you retire earlier, it’s important to consider the potential downsides. Your take-home pay may remain the same, but your salary is technically lower. This might affect your ability to borrow in the future if lenders consider a multiple of your salary when deciding what they will offer you.
That said, certain lenders may consider salary sacrifice and assess your monthly income, rather than your annual salary, when making their calculations.
Additionally, if your employer provides life cover, the benefits paid to your family on your passing are normally linked to your salary. By reducing your salary, you might also affect the level of life cover you receive.
Finally, benefits such as Statutory Maternity and Paternity Pay could also be affected if your salary changes.
The retirement saving advantages of salary sacrifice could outweigh these disadvantages, but you may want to seek professional advice before deciding if it’s the right choice for you.
Get in touch
If you want to explore the benefits of salary sacrifice, we are here to help.
Please get in touch or email us at advice@mlifa.co.uk for more information.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.